Sensible Tax Reform: Based off the Republican Blueprint
When talking about Tax Reform it is trite to put forward the ideal, and while this is often good in helping clarify our thinking about the issues and the "what ifs" in a perfect world, we economists often get caught up in that world and mistake it every so often for the real world. We forget our origins that we came from a philosophy of thought that was originally meshed with political reality.
So while today we watch as Congress mulls over the prospect of what bill will come out of Conference and with a wave of lobbying by potentially affected parties, having weighed in on the consequences of the House and Senate bills, I put forward here what I would call a sensible tax reform in large part based on the blueprint from both the House and Senate bills.
The Republicans control both Congress and the presidency so Tax Reform will be in line with their political economic ideology. I make no attempt at identifying the magnitude and influence of particular lobbies on each of the issues or how perhaps certain policies may tilt some Republicans to vote No who previously voted Yes, and I understand this may be crucial especially in the Senate. So at some level I am reverting to the comfort of economics, but I still feel that because it is in large part based on what is in the bills that have passed in both the House and Senate that I may still be proposing something that is politically feasible, so here goes...
True tax reform should be something that offers permanence and not some mirage designed to meet some financial constraint. The tax cuts proposed for individuals should be permanent and the House version with four new brackets looks great. The four income tax brackets offers the added attraction of being simple. In many of my iterations comparing the impact of the House and Senate versions, the computed tax liabilities were fairly close though the Senate version in almost all cases yielded lower tax liabilities. So my going with the House version also offers some cost reduction especially since I insist that it should be permanent.
To further save on costs the standard deduction should be increased to $12,000 for single filers (and $24,000 for married joint filers), which is the House version. The personal exemptions should also be eliminated as between the higher standard deduction and the expansion of the child tax credit, tax liability under this proposal is still computed to be lower. Speaking of the child tax credit the Senate version looks to be the more generous (and obviously costlier). It however is an indirect subsidizing of an activity that incentivizes work effort so I approve.
Coming to deductions, it sounds plausible to eliminate the Mortgage interest deduction. To the extent that there is concern that this artificially pushes up home prices and promotes a bubble then for long run economic health and reasonable tax reform it should go. Here I add to the Senate version by suggesting it is eliminated for both purchases and debt equity.
Similarly I am with the Senate plan to eliminate the SALT and property tax deductions. These deductions are among the biggest that itemizers typically claim on their tax returns however under current law only about 30% of filers itemize, further, the expansion of the standard deduction is projected to further reduce this number to below 10%. The economic rationale for these deductions to begin with is weak. States and Localities should be able to make their case on the merits of any tax increase and not make their pitch based on how such increases are subsidized by the taxpayers ability to claim a SALT deduction on their taxes.
The Medical expense deduction should also be eliminated as the House bill recommends. While this may look on face value to be unfair to those chronically ill and with high medical bills, with the elimination of the other deductions, it is very unlikely that there will be many whose itemizing of this will make them better off than taking the standard deduction.
On to above the line deductions, again to keep whatever costs down and to still simplify the tax code, however little, the House plan to eliminate the pocket expenses for teachers should hold. Similarly both bills already agree to eliminate the deductions for student loan interest and moving expenses so yes to these as well. There is really no economic rationale for these deductions as there should be enough personal incentives, in the form of expected higher rewards, from carrying out the activities that give rise to the costs for which deductions are claimed. I do think though that the exemption from tuition waiver should continue in place as suggested by the Senate. It just feels weird to have to consider the waiver as taxable income. It is like taxing the poor for trying to get out of poverty.
Now since Congress is indeed constrained by a rule that they do not increase the deficit by more than $1.5 trillion over 10 years, it may make sense therefore if necessary to keep in place the AMT for individuals (and corporations), and to eliminate the Individual Mandate under the Affordable Healthcare Act, as the Senate bill proposes. It is instructive to note that this is in keeping with the Republican agenda to repeal the Affordable Healthcare Act and this inclusion affords them a chance to do so as part of a cost reduction measure by explicitly reducing Federal spending on associated subsidies. The flip-side to this however is that there may simply be a trade-off for individuals who obtain lower tax liability but have to spend more on healthcare, making them no better off and possibly worse off. Healthcare costs will go up if insurance companies cannot get a pool of both healthy and sick people paying insurance premiums and from the reintroduction of adverse selection and moral hazard into the healthcare market.
My main break with the existing Republican agenda is on the Corporation Tax which I dare say is still in the spirit of the Republican ideology and this is to incentivize the Corporation Tax reduction in a way analogous to the EITC. If the goal as has been touted repeatedly is to give corporations the much needed breathing room to expand production, hire workers and increase incomes- the whole trickle down nine yards, then let the tax reduction be retroactively based on having met these outcomes by some clearly measurable yardstick. So yes the Corporation Tax rate should be reduced to 20% but for qualifying corporations that have met the assumed actions that they are predicted to carry out with the policy in place. So keep the Corporation Tax at its current level and for Corporations that meet the criteria on jobs and income growth, retroactively provide them with a tax credit so that they pay effectively a 20% Corporation Tax. This way the cost of the policy can be kept in check as corporations will not just get a freebie while offering nothing back to the economy in the form of growth inducing outcomes.
With respect to other businesses - the ones currently treated under current law as pass-through entities, both bills are agreed on excluding professional services from the new benefits they promise other pass-through entities. There is a potential problem here from a competition point of view which may penalize a company offering similar services as another one, which happens to be a corporation, because it is organized differently. This penalty happens if the corporation now enjoys the 20% tax, while the professional service business is still paying taxes possibly at the 32%, 35% or 38.5% rate. It stands to reason then that for both simplicity and keeping the playing field fairly level that the bill should extend the House plan of a flat 25% tax to all pass-through businesses.
The proposal on expensing being increased is something both bills assure. I will suggest going with the House on this and keeping it at $1 million instead of the $5 million the Senate suggests and subject to phaseout as well. The expensing deduction makes economic sense as an incentive to accumulate physical capital that is necessary for economic growth.
The one time repatriation tax to encourage corporations to bring back assets banked abroad back to the US is also a done deal in both bills, the only difference is in the tax rate for liquid and illiquid assets. I would suggest the Senate version, being the higher of the two by .49%. It allows for some revenue generation so as to save on the cost of Tax Reform. Along the same lines, the move to a territorial system with rules to prevent base erosion is economically sound. This creates incentives for businesses to remain domiciled here and not elsewhere.
The final issue I address is that of the Federal Estate Tax. There is no plausible reason for expanding its exemption or for phasing it out. More importantly to help reduce the cost of Tax Reform the Federal Estate Tax should still be kept in place. It is important to at least explain this viewpoint. In a strict economic sense the estate tax is seen as a tax on capital accumulation which is undesirable, however I think that is more of a narrow perspective and the true bigger picture should be that of a society that is open and dynamic. The perpetuation of an estate or family wealth intergenerationally is made possible through the maintenance of a social contract that defines societal relations and obligations as well as a duty to provide equal opportunities to new entrants. The norms of hard work, dignity in labor, and respect of people from all works of life become increasingly eroded through the creation of an elitist detached class whose status is solely due to acquired wealth. The estate tax helps to mitigate this perverse outcome through a payment that perhaps mimics what would otherwise in Economics be referred to as a Lindahl price for maintaining the societal structure of trust, for which the estate inheritors implicitly value highly as having been responsible through being the enabling environment for the existence, creation, and protection of said wealth that has now been transferred to them.
In this sense it is not a death tax but rather a life tax. It is a payment that acknowledges the existence of a public good that has allowed wealth to be accumulated and handed down to another generation so that from these funds the social structure can continue to live.
So this is my view on what a sensible tax reform that conforms to Republican ideology should be - based on the blueprint of what has currently passed in both the House and Senate, with a few modifications based on the economics they subscribe to, and one that does deliver on all dimensions of what the tax reform has been touted to deliver on: tax relief to Americans and American companies, simplification of the tax code, and spurring of economic growth.